Why Draghi Blasted Renzi

Mario Draghi gave an important speech this week on the future of euro-zone integration. It went to the heart of the core debate that has always lain at the heart of the euro crisis. This is not whether the euro will survive, but whether it will survive on German or Italian terms: will it be a “discipline union” in which countries must stand on their own two feet or a “transfer union” in which debts are pooled? Mr. Draghi made it clear whose side he is on—and it’s the side of the country where he lives and not the one where he was born.

For over a month, debate in Europe has been dominated by Italian Prime Minister Matteo Renzi’s campaign for greater “flexibility” in the application of the euro zone’s fiscal rules—code for allowing countries to run bigger deficits. Mr. Draghi’s speech was a thinly veiled rebuke to Mr. Renzi. The stability of the euro zone depends on enforcing the existing fiscal rules—“not on having more flexibility,” he said. “To unwind the consolidation that has been achieved, and in doing so, divest the rules of credibility, would be self-defeating for all countries.”

Mr. Draghi gave three reasons why the much tougher fiscal rules introduced at the height of the crisis in 2011 are in the best interests of the euro zone and must be observed. First, because public debt in the euro zone is far too high. This makes countries less able to absorb shocks, increasing contagion risks for other member states. Second, because the fiscal rules can actually lead to better policy-making by forcing governments to make growth-friendly budgetary choices. And third, because respect for the existing rules is an essential precondition for building the mutual trust needed to allow the euro zone to take further steps towards integration needed to boost the bloc’s growth potential.

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But Mr. Draghi didn’t stop there. He went on to argue that the euro zone should be given similar powers to force governments to implement structural reforms. If high public debts are a threat to the stability of the euro zone, so too are uncompetitive economies, he said. Major differences between countries in terms of the ease of doing business or time taken to set up a new business can make it much harder for countries to adjust, leading to persistent economic imbalances. The entire euro zone, he said, has a direct interest in ensuring that national governments implemented necessary reforms.

Mr. Draghi singles out Greece and Malta as examples of two countries that scored particularly poorly in recent surveys of business conditions. But it is hard to believe that Italy wasn’t again at the front of his mind. Mr. Draghi has devoted a large part of his career to fruitless appeals to Italy’s political class to embrace reform, both as head of the Italian Treasury in the 1990s and as Governor of the Bank of Italy before taking up his current post. But this hasn’t prevented Italy’s long slide towards is current status as the sick man of Europe. Despite bold promises, Mr. Renzi’s reform achievements are so far meager.

It is not clear how Mr. Draghi thinks structural reforms should be policed at euro-zone level. Perhaps he had in mind some variant on German Chancellor Angela Merkel’s proposal of contractual arrangements whereby countries could receive incentives in the form of cheap euro-zone funds if they commit to reforms. But Mr. Draghi’s conversion to the idea that country’s should yield sovereignty over such politically sensitive powers speaks volumes about his confidence in the capacity of euro zone politicians to deliver reforms that are in their own country and the euro zone’s best interests.

Many Italians—and many investors—are betting that Mr. Renzi can succeed in delivering reforms where two decades of politicians have failed. But it seems that at least one well-placed Italian is skeptical of how much reform countries with weak institutions like Italy can really deliver without stronger external pressure. Indeed, Mr. Draghi has a particular reason to be worried: if lack of progress with reforms continues to weigh on euro-zone growth, then pressure for an “Italian solution” to the euro crisis will become irresistible—and it will be Mr. Draghi via the ECB balance sheet who will have to provide it.

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